Post-Olympic slowdown and AMCs troubles paying their debt

The stock market continues to behave poorly, with the SSE Composite dropping 2.6% on Tuesday and 0.3% Wednesday before reversing Wednesday’s losses to close up 0.3% today at 2350. The weak rally was driven by higher-than-expected profits among consumer-related companies, although I wonder how much of that increase was caused by a one-off jump in Olympic-related spending. At any rate once again we are close to the 2300 level, although during my meetings in Shanghai yesterday some of the fund managers spoke of 2250 as being the level at which we were expected to see government support. Who knows? At any rate they weren’t a particularly enthusiastic bunch.

I am not allowed to be too specific about details, but one impression I got from these meetings is that new equity funds launched in recent months have been supported by some pretty aggressive selling, with high-fee incentives paid to the commercial banks and brokers who are responsible for raising the money. This is all very impressionistic, and I don’t have concrete details, but I wonder if some of the retail investors who have put money into the funds are fully aware of the risks they are taking. When salesmen are put under significant pressure to sell new funds to retail investors, and are rewarded with high fees when they do, there is always the risk of salesmen misstating the risks and rewards associated with the fund.

This could be a problem if markets continue to decline, and clearly the possibility of further declines weighs heavily on the administration. Today in the China Daily there was yet another article (these have become regular appearances in the Chinese press) arguing that a post-Olympic slowdown is unlikely and quoting a host of experts, including inevitably, Lin Yifu, the chief economist and vice president of the World Bank, who believe that there are few risks of a post-Olympic recession. Still, in the same edition the newspaper had another article called “Economy to face challenges in second half,” in which it warned about the increasing uncertainty:

China’s economy has maintained steady and rapid growth in the first half but faces increasing uncertainty for the rest of the year, a senior government official said Wednesday. “Negative impact on the economy will continue,” said Zhu Zhixin, vice-minister of the National Development and Reform Commission (NDRC), China’s top economic planner, in a press conference.

In support of Zhu’s concerns, there was an interesting if alarming Op-Ed article in today’s Financial Times by Joe Quinlan, chief market strategist at Bank of America, who argues that global private consumption, which jumped 11% in 2007 and rose by an average of nearly 8.5% a year from 2001 to 2007, is likely to rise by only 2-4% this year. He warns (and I agree) that the global de-coupling thesis doesn’t take into account the huge rise in developed-world consumption as a share of total consumption, which itself explains the growth in developing countries exports as a share of total exports.

Add to that further problems in the US banking sector – an article in today’s South China Morning Post says that the FDIC’s list of problem banks increased by 30% in the second quarter to the highest total in five years – and China clearly needs to worry about a downturn in global conditions. If world consumption slows, this is likely to be a real problem for countries like China.

The China Daily article goes on to report on Zhu Zhixin’s press conference:

China’s grain production amounted to 120.4 million tons, a record high. The authorities also managed to restore pork and vegetable production, despite natural disasters such as snowstorms and earthquake hitting the economy hard, Zhu said.

However, analysts have said that the outlook for the sector is uncertain with extreme weather posing a challenge. Rising prices of fuel and fertilizer have also eaten into the profits of farmers, which may serve to discourage increases in production in the second half, Zhu said. He added that the government will continue to support the agriculture sector.

That sounds ominous. The one success in the fight against inflation has been that food prices, after a dizzying rise late last year and early this year, have receded somewhat. For those of us who believe the fight against inflation has been all but won, this suggests that with the main driver of inflation in deflationary mode, there is little risk of another upsurge.

Those who believe the fight against inflation has only just started will argue that a relaxation of food prices is not unexpected given the huge and clearly distorted run-up earlier in the year. The question is whether inflation will spread to the non-food sector or whether there will be further interruptions in food supply that create another round of food-led inflation. My understanding is that there is little room for any disruption in food production and there are significant shortages in energy – which both suggest a bigger probability of an upside surprise than of a downside surprise.

he Chinese government will stick to an economic policy that focuses on curbing inflation for the rest of the year, a senior official on Wednesday told China’s top legislature, as slowing output and rising prices loom over the post-Games economy. Economic planners would exert themselves to increase supplies of necessities, closely track key prices and make price controls more effective, National Development and Reform Commission deputy chief Zhu Zhixin told the fourth session of the Standing Committee of the 11th National People’s Congress.

“A lot of factors can drive prices up,” said Zhu. “There is a strong demand for primary products, with prices hovering high on international markets, while more expensive land and labor at home will add to costs.”

In spite of these inflation warnings few analyst expect that there will be further monetary or credit tightening – in fact there are a lot of rumors going around that the PBoC’s next move, coming soon, will be a reduction in minimum reserve requirements. Since the lending caps have been the main constraint on loan growth (and they are being relaxed), not the minimum reserve requirement, I am not sure I believe the rumor, but even if it is true it is not likely to have a big impact.

On a separate note a lot of local newspapers are reporting a release yesterday by the Auditor-General Liu Jiayi. According to an article in today’s People’s Daily:

Central government departments and their subordinate units misused or embezzled about 4.52 billion yuan ($661.09 million) last year, for which 14 officials have been detained, the country’s top auditor said yesterday.

If the NAO is truly able to ferret out fraud, graft and misuse of funds, this is clearly a good thing for China. One thing that did catch my eye, however, was that, according to an article in today’s Financial Times, “The audit also found that China’s four state-owned asset management firms – Huarong, Cinda, Great Wall and Orient – could face difficulties because they had not earned enough from selling non-performing assets to pay the interest on their debt.”

The asset management companies (AMCs) were created to help resolve the NPLs on the balance sheets of the big banks. For the most part they purchased NPLs at either 100% of face or 50% of face, and “paid” for these with their own bonds. Since as far as I can remember the collection rate on these NPLs has not been much higher than 20%, it is clear that except for the MoF guarantee these AMC’s would be bankrupt, and because of the MoF guarantee the amount by which they are insolvent should be included as part of MoF liabilities (they usually are not included in most analysts’ calculations of total government debt).

What is interesting to me is that not only are the AMCs unlikely ever to make their principle payments, but they are also having difficulty making interest payments. I wonder if any of the readers more expert than me on the subject (hint: are you reading this Jack Rodman?) might comment on this. I would be interested in hearing how healthy the AMCs are and whether there is a more accurate expected collection rate than the roughly 20% I remember having read a year or so ago.

All the Washington Consensus Economists routinely deride China’s Economic performance as absolutely unsustainable and heading for an imminent collapse. But the imminent collapse of the Chinese economy has been predicted for well over two decades already. And the Beijing Olympics didn’t crash and burn as the US Neo-liberal media promoted. LOL.Chinese skyscraper builders to put up equivalent of 10 New Yorks, says Rio Tintohttp://www.guardian.co.uk/business/2008/aug/27/riotinto.commoditiesRio Tinto yesterday shrugged off talk of an impending collapse in the commodities market, pointing to recent research that suggested China will build up to 50,000 skyscrapers in the next 20 years, the equivalent of 10 New Yorks, creating sustained long-term demand for steel and other raw materials.Some analysts had been forecasting a dip in Chinese investment after the Olympics, but Rio is predicting that there will be a post-games boom. The company cited research from McKinsey, the management consultancy, which said the scale and pace of urbanisation would continue at an unprecedented rate.By 2025, the report predicts that China will have 221 cities with more than a million inhabitants, compared with 35 in Europe today. As well as the need for huge spending on infrastructure, McKinsey projects that China will build between 20,000 and 50,000 skyscrapers, many of them in less developed interior provinces far from Beijing and Shanghai.The company said that North America and Europe were becoming decreasingly irrelevant to the setting of metals prices, as demand is driven by China, India and other emerging markets – Chinese imports of iron ore are running 20% ahead of the same point last year. In the first half of the year, Rio lifted prices of iron ore by an average 86% compared with 2007, even as economies in North America and Europe were weakening. The average copper price charged by Rio in the first half was 20% higher than last year, gold was 38% higher and aluminium prices were up 2%. The company said 2009 was likely to be the sixth successive year of higher prices.

M. Pettis September 1, 2008 at 6:49 am

You make a fairly common mistake. In fact there have been at least three serious crises in the past thirty years (1985-87, 1993-94, and 1997-98), but since China was too small and too unrelated to the world economy for their imapcts to have been felt outside China, we all sort of assume that they don’t matter. Generally speaking I guess a crisis isn’t rally a crisis unless bankers feel it.Still, according to the World Bank, the mid-1990s banking crisis cost China 55% of GDP, which is far more than any of the US banking crises of the past thirty years has cost. One of my CPC friends who was an advisor to the economic policy-makers at the time said the 1993-94 crisis came closer to bringing the party down than any other crisis in his experience.